I am looking at Q1 of the ST1 Sept 2012 Exam Paper which is asking why the risk discount rate used for product pricing may contain a risk premium Can someone please check if the answer given below would be correct If corporate bonds are used to back the liabilities of the product then the default and credit risk would need to be reflected in the risk premium. Also the volatility and uncertainty of the return (including MV) for equities and properties would also need to be reflected in the risk premium. The shareholders would expect a higher return for investing their capital and the excess return would need to be reflected. Finally any prudent margins requred in the other assumptions such as morbidity, mortality can be allowed for through the risk premium. Many Thanks
This question is mainly just bookwork from Chapter 13 (the start of Section 3.1). It's a lot more general than looking at the risks associated with the assets held to back the liabilities - it's about the overall risk of investing in a company. The company will need capital in order to write new business. Providers of capital (for example shareholders) will need a return on their capital and the risk discount rate will reflect this required return, which will consist of a risk-free rate plus a risk premium. I hope this helps - the Examiners' Report will be out in a few weeks, so you can check the detail in that
